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CHAPTER 6

Total Economic Cost

In the procurement of commercial products, Government officials at every level tend to focus on the “price paid to the supplier" rather than on the total long-run cost of satisfying a Government requirement. As a result the Government has failed to develop the data and techniques needed to measure the “total economic cost” of fulfilling a Government need.

This chapter addresses three types of costs related to the acquisition and use of commercial products:

Support Cost. The cost of the support systems the Government uses to acquire and provide commercial products to the ultimate user. Landed Cost. The total cost to provide an item to its user. This includes the price paid for the item and its allocated share of the cost of the support system, or systems, used to acquire and deliver it. Total Economic Cost. The landed cost of an item plus costs incident to its use, and disposal or consumption.

The chapter summarizes the results of study group analyses of support and landed costs and discusses the compelling need for total system management. Recommendation 6, Chapter 4, encompasses consideration of types of costs, discussed in this chapter, as basic to analyses of effective procurement and distribution systems. The elements of landed costs analyzed in this study are shown in figure 1.

segregate costs of procurement and distribution systems, thus necessitating the prorating of these costs. Where necessary, we developed our own estimates from the data furnished and made adjustments for missing data. In some cases, we did not include elements of cost if the information was not critical to the development of support costs. For example, we did not include costs of disbursement of funds at station level for payment of commercial accounts. Our approach was consistent with the cost-effectiveness and analysis guidance used by the Department of Defense (DOD).'

The resources used in procurement and distribution were identified, measured, and priced. For interagency programs, available accounting data were used to develop costs related to capital resources. Return on invested capital was costed at ten percent per year. For base activities, we took the average costs of transactions and the cost of personnel as furnished to us. Costs fell into three general categories:

• Appropriated fund costs that primarily included personnel and operating expenses of the support provided • Stock or revolving fund costs that primarily included transportation and inventory loss costs (except in the case of the Veterans Administration where operating expenses are funded by its revolving fund) • Unfunded costs that were primarily investment costs reflecting depreciation and return on invested capital. Annual appropriated funds that might have reflected capital re

METHODOLOGY

* U.S. Department of Defense, DOD Instruction 7041.8, Economic Analysis of Proposed Department of Defense Investments, Feb. 26, 1969.

? U.S. Office of Management and Budget, Circular A-94, Discount Rates to be Used in Evaluation of Deferred Costs and Benefits, Nov. 15, 1971.

The cost data received from agencies did not

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erning the acquisition of commercial products are not consistent among the Federal agencies, and agencies generally do not give adequate consideration to total economic cost. In establishing and operating procurement and distribution systems, they often fail to consider adequately the costs of alternatives. This results in higher costs and raises questions about operating costs between Congress and the executive branch, among agencies, and between industry and Government.

pairs or minor construction were not adjusted for this factor.

Costing was based on data for fiscal 1971. Activity in that year was declining from the peak of the Vietnamese conflict. This had some impact on operations, mostly in property disposal and the reduction of inventories, as exhibited by low procurements in relation to sales.

The purpose of our cost analyses is not to show relative efficiency. Rather, it is to highlight the magnitude of costs of available alternatives and whether alternative choices would offer the Government opportunities for savings in the procurement and distribution of commercial products. In establishing a support system, various alternatives sometimes compete with and at other times complement one another. Thus the decisions must reflect both the best choice among alternatives and the best combination of approaches to support the specific needs of a given using activity.

As discussed in Chapter 4, the policies goy

INTERAGENCY SUPPORT COSTS

We estimated the costs of the interagency support provided by the Federal Supply Service (FSS) of the General Services Administration (GSA), the Veterans Administration (VA), and the six inventory control points (ICP) or supply centers of the Defense Sup

ply Agency (DSA). Table 1 summarizes the total volume of procurement for each of these eight interagency support organizations during fiscal 1971.3

TABLE 1. PROCUREMENT BY INTERAGENCY

SUPPORT ACTIVITIES
(Stock and Direct Delivery)

Fiscal 1971 procurement Activity

(thousands of dollars) FSS (excluding ADPE)

Depot stock and vendor delivered 730,425
VA

Depot stock and vendor delivered 102,788
DSA Supply Centers
Construction (DCSC)

336,000 Electronics (DESC)

157,700 General (DGSC)

210,000 Industrial (DISC)

115,200 Fuels (DFSC)

1,295,800 Personnel Support (DPSC) Clothing (C&T)

272,900 Medical

183,500 Subsistence

946,353 Total

4,350,666

of support provided. This was done to estimate the costs of major types of programs and to avoid aggregating types of support that have different cost characteristics. Although we were able to define meaningful programs, certain minor distinctions in programs could not be made due to lack of data.

Appropriated fund data were taken from DSA and FSS accounting systems. Data on VA interagency support activities were obtained from its revolving supply fund records. Costs of support programs were obtained from accounting records and other data furnished by the agencies, or were derived by the Commission in the course of its analyses.

All appropriated fund costs were allocated either to a support program or to “other” activities. Overhead and headquarters costs were allocated to activities at several levels.

For DSA, the major “other” activities were the Defense Contract Administration Services, the Defense Logistics Services Center, the Defense Industrial Plant and Equipment Center, and services provided by DSA centers, depots, and headquarters for Federal agencies.

For FSS, the major “other” activities were the Office of Automated Data Management Services, Federal Supply Schedule Program, GSA business service centers, procurement regulation activities, and certain specification and standards activities.

The result is summarized in table 2.

As can be seen from the funds allocated to “other” activities, an effort was made to segregate activities not directly related to the sup

Source: Appendix F, table F-1.

These eight organizations provide a wide range of supplies and services and each year account for more than $4 billion in procurement. They procure and distribute commercially available products, special goods, and, in the case of DSA, a significant number of military products.

The major procurement and distribution programs of each of the eight organizations were defined on the basis of available data and type

'Appendix F, table F-1 indicates the largest product groups procured by each of these activities. Indefinite delivery contract programs, such as Federal Supply Schedules, where ordering is accomplished by the using activities, are not included in the data of table 1.

For example, the inclusion of direct vendor delivery of stocked items in the stock support programs analyzed tends to reduce the cost shown for the stock support program by attributing storage costs to a greater quantity of items than were actually stored.

TABLE 2. APPROPRIATED FUND EXPENSE OF
INTERAGENCY SUPPORT ACTIVITIES
(Thousands of dollars)

Cost allocated to support programs

Cost allocated to Activity

Total

"other" activities DSA* DCAS

313,080

290,070 DLSC

20,938

18,007 Centers

261,273

19,474 Depots

110,426

16,854 Other

10,337

10,337 Total DSA

716,054

354,742 FSS

88,622

12,481 Source: Study Group 18A Final Report, vol. II, part VII, ch. 2. exhibit VII-2-7, pp. 705-709. •Total costs of each activity include allocation of DSA headquarters expenses.

23,010

2,931 241,799 93,572

361,312 76,141

all DCSC products, both commercial and military peculiar. • DCSC sales in fiscal 1971 were $275 million, of which $199 million were delivered from inventory. • The obsolescence rate was high in relation to the stock support of $199 million when related to the fact that DCSC sent $122 million to property disposal.

port programs being analyzed. Costs arising from an activity's compliance with legal and regulatory restraints, socioeconomic programs, and other requirements were treated as normal costs of doing business.

Revolving stock fund costs were obtained from annual financial statements. Adjustments were made to eliminate general and administrative costs not applicable to interagency support.

Costs not included in any accounting record were primarily return on invested capital and depreciation. Values for real and personal property were obtained from agencies on a best estimate basis. The allocated costs of inventory, cash, and accounts receivable were obtained from stock fund financial statements. We could not compute all costs that might be relevant. If thought to be significant, categories of missing costs were identified."

TABLE 3. DCSC OPERATING STATISTICS,

FISCAL 1971

(Thousands of dollars) Inventory (July 1, 1970)

481,334 Sales (fiscal 1971)

275,368 Delivered from inventory

199,053 Obsolescence indicators (fiscal 1971) Property disposal by DCSC

122,572 Returns from customers

68,503 Property disposal by customers as directed by DCSC

100,953

Obsolescence Costs

Source: Defense Stock Fund Report, Construction Supplies Category, June 30, 1971 and data furnished by DSA which showed using activities had requested permission to return goods valued at $204 million, excluding automatic returns. Of this, $103 million was authorized for return, leaving a residual of $101 million for disposal by the using activities.

In this report, the term “obsolescence costs" includes the cost of items removed from inventory as excess to current and projected needs. This condition may be due to technological obsolescence, overprocurement, or reduced usage. These costs may arise for any number of reasons, such as the need to maintain military readiness.

Obsolescence costs are significant and were particularly high in fiscal 1971 because routine property disposal operations had been suspended during fiscal years 1966–1969 due to the Vietnamese conflict. These costs can be deferred and are not accounted for until disposal action is taken.

Obsolescence in relation to regular operations at the Defense Construction Supply Center (DCSC) illustrates this problem. The DCSC inventory investment, sales, deliveries, and obsolescence measures are shown in table 3.

From table 3 it can be seen that: • Total DCSC inventories at the beginning of fiscal 1971 were $481 million. This includes

Obsolete inventory is probably an unavoidable cost of supporting changing customer programs. However, inventory managers tend to base their forecasts of future needs and plan inventories on movement from inventory rather than on current customer usage. Stocks and pipelines can be full on the day equipment is removed from service. This is particularly true where supplies to meet repair needs increase with the age of the equipment.

Because of the high cost of obsolescence and the inability to predict its occurrence, we costed DSA operations using four different measures of obsolescence cost as reflected in inventory and accounting adjustments.

6 All four measures are shown in Appendix F for DSA but only "with obsolescence" and “without obsolescence" are shown in table 5 of this chapter. The four measures are:

Estimated economic losses reflected in stock fund cost accounts for fiscal 1971 indicate the cost of inventory disposed of or the cost to put it in saleable condition. Changes in value of inventory also were included in this measure. Highest costs generally are found in this category ("with obsolescence").

Surcharge costs for inventory losses for fiscal 1971 as reflected in the DSA surcharge policy. These are accounting charges that are to be recovered by the surcharge income. They primarily reflect charges and credits associated with keeping the stock fund financially healthy as opposed to measuring obsolescence directly.

Surcharge income for fiscal 1971 which reflects DSA's long-run view of average inventory loss.

No cost for inventory losses was considered as the final alternative ("without obsolescence").

5 For example, the cost of storage facilities provided to DSA by the military services other than those integrated into DSA's regular storage programs; the cost of Government disbursement not borne by the activity itself.

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Activity

Procured Federal Supply Service (FSS)

$ 30.32 Veterans Administration (VA)

13.90 DSA Centers (w/obsolescence) Defense Construction Supply Center (DCSC)

122.20 Defense Electronics Supply Center (DESC)

107.97 Defense General Supply Center (DGSC)

110.81 Defense Industrial Supply Center (DISC)

132.82 Defense Personnel Support Center (DPSC) -Clothing and textiles

84.48 -Medical

48.68 -Subsistence

24.55 DSA Centers (w/o obsolescence) Defense Construction Supply Center (DCSC)

73.39 Defense Electronics Supply Center (DESC)

68.89 Defense General Supply Center (DGSC)

78.58 Defense Industrial Supply Center (DISC)

97.52 Defense Personnel Support Center (DPSC) -Clothing and textiles

67.43 -Medical

44.49 --Subsistence

23.83 Source: Appendix F, tables F-2 through F-6. •The term “sold" is used to denote the action of having Alled support requisitions.

52.01 47.50 24.16

55.48 53.14 49.35 65.98

41.52 43.41 23.44

Interagency Depot Stock Support Programs

The total cost of the depot stock support programs analyzed is shown in table 4.

The average estimated cost of purchasing and distributing $100 worth of stock in depot programs of the three agencies was $55.73. The total estimated cost of these interagency depot stock support programs is well over $1 billion annually.

Table 5 summarizes the results of the cost analysis for the individual stock programs.

The following observations can be made from these cost comparisons:

• The cost per $100 sold is lower than the cost per $100 procured when an agency is

reducing stock levels because the cost of
operation is charged to a larger base.?
• Stock support is expensive, ranging from
$16.30 to $92.38 per $100 sold when obsoles-
cence costs are included. 8
• VA costs are the lowest of the activities
shown. We attribute this to the VA's restric-
tive criteria for stockage that exclude items
with poor economic characteristics so that
volume and turnover per item are higher and
to the type of products and limited product
lines (food, drugs, and medical supplies) for

? Fiscal 1971 was a year of declining activity after the Vietnam build-up and inventories were being reduced.

8 When measured against procurement, several DSA activities show annual costs in excess of the value of procurement for fiscal 1971 (DCSC, DESC, DGSC, and DISC).

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